Entrepreneurs often find tax filing to be overwhelming, as they must navigate through profits, losses, and various tax implications. Luckily, deductions offer a way to reduce tax liability and overall tax bill. Understanding eligible deductions can be challenging whether using tax software or consulting with an accountant. To simplify this process, experts recommend exploring specific tax deductions that can save money for both you and your business.
Consider the entity type of your business carefully. For instance, in a sole proprietorship, self-employment taxes can be high due to paying Social Security and Medicare on the entire net income. On the other hand, operating as an S-corporation can help avoid double taxation and provide self-employment tax savings. Shareholders in an S-corporation can take a reasonable salary and distributions, with only the salary subject to self-employment tax.
Planning for retirement savings can also yield tax benefits. By contributing to a traditional 401(k), you can potentially reduce your tax bracket and enjoy tax savings. Additionally, taking advantage of home office deductions can result in deductions for various expenses such as mortgage interest, property taxes, utilities, and maintenance based on the percentage of your office space in relation to your home size.
Furthermore, entrepreneurs should be aware of the Foreign Derived Intangible Income (FDII) deduction, which is available to corporations and can reduce the tax rate on sales of certain items. By exploring these tax-saving strategies and deductions, you can potentially save significant money during tax season.
“The tax expert explained that by restructuring to a corporation outside the US, businesses can lower their effective tax rate from 21% to 13.125%. This reduction can be especially beneficial for companies selling intangibles like software or video game assets, as a significant portion of their sales come from international markets.
Looking ahead to 2025, there are currently no new tax credits or deductions, but this may change with the return of President Trump to office. The Tax Cuts and Jobs Act is scheduled to expire at the end of 2025, creating pressure to enact new tax laws either this year or early in 2026 to extend popular tax provisions.
One common pitfall when claiming deductions is related to Section 179 research and development expenditures. Entrepreneurs often overlook the requirement to amortize research and software development costs over five years if conducted in the US, or 15 years with an overseas team. This can significantly impact the tax liabilities of startups, potentially resulting in taxable income even with an overall negative cash flow.
It’s crucial for software development companies to manage these expenses carefully, particularly in the early stages of generating income. Caitlyn Moorhead contributed to this article.
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